Gaming - the new black

“The view we take … is that culture arises in the form of play”

Johan Huizenga, author of “Homo Ludens”, 1938

Homo Ludens has been around since the dawn of humankind and is core to our existence. Here, we want to point out how important gaming is becoming as a force of our economies, why this trend will last, and how to benefit from it as an investor.

The size of the global gaming market breached the $100 billion mark a few years ago and was $151bn in 2019. We use “gaming” to mean video games and not traditional board games and toys. As a comparison, the global toy market is only $103bn in sales. While traditional entertainment is stagnating, the sports market is growing at 5% p.a. and gaming at 9% p.a. Video games have lost most of their social stigma while expanding by gender and age. Each new technological platform – arcade, console, PC, handheld, smartphone, and virtual reality – brought more diverse users. In addition, what was originally a geeky, tech-oriented industry is now considered the new creative power. Gaming companies speak of publishing studios much like the film industry, rather than software development.

The history and development of the industry can best be summarized as:

• Pong (1971),

• Space Invaders (1978),

• Pac-man (1980),

• Mario Bros. (1983),

• Tetris (1989),

• Madden NFL (1988)/FIFA (1993),

• Pokemon (1996),

• Grand Theft Auto (1997),

• The Sims (2000),

• Animal Crossing (2001),

• Call of Duty (2003),

• World of Warcraft (2004),

• Wii Sports (2006),

• League of Legends (2009),

• Minecraft (2011),

• PUBG (2017)/Fortnite Battle Royale (2018),

• Among us (2020).

If you do not have at least an image in your mind of these games, you have lived a very intellectual life. If you have actually played all of these games, you may have lived a life not intellectual enough😉. Actually, the games listed here either rate as the highest selling games of their time or defined a new genre of gaming.

Unlike the software technology concentration of silicon valley, gaming has become a truly globally intertwined industry. Many of the original gaming trends originated in Japan. The most successful current gaming publisher, EPIC Games (Fortnite) from North Carolina, USA, is now jointly owned by its founder and Tencent, the Chinese internet conglomerate. Minecraft was created by a Swedish developer and then acquired by Microsoft. Within Europe, Sweden has become the hotspot for publicly listed gaming companies. While these companies’ publishing studios are around the world, Swedish investors were early to recognize and understand the gaming trend. Perhaps surprising to some, Poland has emerged as a gaming hub thanks in part to low labour costs, a young educated workforce and a gaming tradition.

For the industry as a whole, we can observe an impressive diversity in business models (from free-to-play to high budget blockbusters), game genres (sports, shooters, fantasy, strategic, simulations/role play, puzzling, building) and devices. Currently, the main driver is the spread of smartphones and other portable devices. Original gamers predominantly used hardware consoles. The fastest growing categories are now mobile gaming, virtual reality and eSports, which leads us to some fascinating crossover effects. Video games have emulated sports, and now the game itself is becoming the sport. The most popular eSports are League of Legends and Dota, both multiplayer fantasy battle games played in tournaments with up to 50,000 spectators in physical arenas. The highest paid tournament now has $25 million in prize money. Even the IOC formally recognized eSports with a planned test run for the 2020 Summer Olympics (now Jul/Aug 2021), fittingly in Tokyo, Japan. Another crossover are movies. Just like in sports, originally movie themes/franchises were built into games, now movies are being made based on successful games (e.g. The Witcher).

We have attempted to evaluate differences in the top publicly listed “pure plays”, i.e. excluding diversified corporations such as Sony, Microsoft or Tencent. A significant part of $725 billion worth Tencent is gaming and $1.5 trillion Microsoft now generates about 10% of revenues from gaming. Nonetheless, the top 20 “pure play” gaming stocks add up to $360 billion in market capitalization. In comparison, Netflix has a market cap of $230 billion.

We have grouped the top 20 gaming stocks by region and added a group of smaller (<€1bn market cap) European players. Profitability comparisons are still difficult as the industry is fast growing, making margins less important at this stage. In addition, investors need to pay particular attention to the accounting of development costs and acquisitions.

The analysis compares the valuation in terms of current year enterprise value-to-sales versus predicted sales growth rates for 2020 to 2022. The US and Japan are at the lower end of valuation (5 to 6x EV/S vs 7 to 8x EV/S for Chinese and European) as they are more established with higher market caps and slowing growth momentum. In contrast, Chinese gaming stocks have the same growth expectations of 15% p.a., but demand a premium as they are seen as the country with highest long-term potential.

While this rarely happens in other global sectors, Europe is actually the most expensive region for gaming stocks. This can of course primarily be explained by the highest growth rate of all regions. That is why the smaller European players seem to be the most attractive with an average expected sales growth of 23% p.a. at a multiple of 8.4x sales, an 8% discount to its large European peers. There is a wide dispersion among these with the EV/Sales ranging from 1.7 to 18.6. What may be interesting to note is the company with the lowest multiple is highly profitable. This leads to a very cheap 9x EV/EBITDA earnings multiple while sporting a 25% p.a. growth rate. It is explained by its lack of coverage as its market cap only recently went above €100million. As a serial acquirer of cheap games, it needs to show it can generate sustainable cash flows.

In conclusion, we believe ample opportunities exist for the gaming industry as a whole and investors can add value through stock picking in this dynamic and still inefficient sector. The best closing remark comes from a game itself: the latest release of Animal Crossing, New Horizons, has introduced the “stalk market” where the villagers can trade their turnips at prices determined by supply and demand. We have come full circle!

The HanseaticHunter

#gaming #longtermpotential #growthstocks #esports #videogames